“I wrote this article Q3 2020. For years, Venture Outsource has been educating and training manufacturing professionals on costing and pricing of contract electronics manufacturing services vs ‘should cost’. This article touches on this but what’s really interesting is how much the macro environment has progressed since writing the article fall 2020.” – Mark Zetter
An edited version of this article was first published on supplychainbrain.com January 31, 2021. The original, unedited version is below.
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United States Fed implements monetary policy primarily two ways:
Federal funds rate and, open market operations.
This article focuses on the federal funds rate. By lowering federal funds rate targets banks pay less to borrow from the Fed, therefore banks have more money to lend. This makes capital more affordable, encouraging companies and investors to borrow.
If a manufacturer’s ROIC for borrowed capital returns a higher rate, this presents manufacturers and supply chain vendors higher liquidity, manufacturers will borrow more from banks and this is just like adding money to the money supply.
The challenge for manufacturers, which will only become worse as inevitable inflation takes hold, is balancing the cost of money (loans and sales acquisition) against the depreciating purchasing power of money.
Manufacturers sales revenue is computed using the present value of paper money. And while sales revenue may increase, the real income (the purchasing power of the sum received by companies) is declining from increasing quantitative easing (QE) by the Fed, the European Central Bank, and most other central banks, worldwide.
Below, the amount of U.S. currency in circulation as reported by the Federal Reserve Bank of St. Louis, one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System.
Similar to updating evaluations for market-to-market scenarios, in this instance the true value of company earnings can be hidden behind artificial numbers. On a side note, some readers might recall September 2019, in the overnight bank lending market when banks stopped lending to each other. It’s because bank balance sheets are being tabulated with figures that are not real and cannot be properly valued.
Meanwhile, US currency debasement (less purchasing power) is emphasized below.
In manufacturing supply chains, the moment a transaction occurs a financial obligation is created and the accounting ledger (tax liability) is fixed in figures. Then, in the period of time from when the liability is determined, to the point in time when the liability is actually paid, manufacturers and vendors/supplier experience further decreasing leverage with purchasing power of their cash and reserves.
Accelerating the decrease of manufacturer purchasing power will continue into the foreseeable future so long as the Fed continues to continue with QE policies.
No manufacturer or supply chain vendor or supplier can offset the inevitable inflation and declining purchasing power based on the debasement of US currency. Even foreign operators rely on the value, or exchange rate, of the US dollar because of its current status, worldwide.
In Western economies the European Union is nearing wits end with the EU’s bond market owned 66% by the State. This means the European Central Bank’s balance sheet now equals 66% of the Eurozone gross domestic product (GDP).
Add to this European pensions are on life support as politicians are coming up with ever-more creative ways to assess more taxes while justifying ways to raise existing taxes.
With the US dollar still being a global safe haven (for the time being) Europe’s bond market is struggling to survive, and Japan’s in far worse shape. There is good reason why two of the most heavily traded currency pairs are EURUSD and USDJPY.
The Japanese Central Bank’s balance sheet equals a staggering 136% of Japan’s GDP. In the US, the Fed is currently at 37%, which will rise as more credit continues to be created relative to a lower US GDP ratio from less being manufactured/produced in the US.
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